Tag Archives: tax consequences

Tax Consequences

Understanding The Tax Consequences Of The Mortgage Forgiveness Debt Relief Act

Over the past couple of weeks there have been numerous news stories, both local and national, citing real estate experts who suggest that if homeowners don’t sell this year, they could face big tax consequences because the Mortgage Forgiveness Debt Relief Act (MFDRA) will expire.

If you are not familiar, the MFDRA was first enacted by Congress in 2007 and it is set to expire this year. Generally, the MFDRA allows exclusion of income realized as a result of modification of the terms of the mortgage, or foreclosure on your principal residence. It essentially allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief.

But the reality is, for many Arizonans, the MFDRA has very little impact because most first mortgages are “non-recourse” loans and most seconds don’t qualify for the tax protection of the MFDRA; therefore, no matter when we sell our homes, we will not be taxed, whether it is in 2012 or 2013, irrespective of whether the MFDRA gets extended.

The IRS website lays this out for us: “a non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income.”

And, here’s the problem: whether it’s because inventories are at historic lows in the Phoenix market, or simply a tactic to get underwater homeowners to sell their homes, realtors are claiming that failure to sell an underwater home this year will result in huge tax consequences next year after the MFDRA expires.

These real estate “experts” are clearly giving self-serving information to homeowners and the media hoping to convince homeowners that they must sell this year. These realtors who tell homeowners to sell this year because MFDRA will expire are giving “tax” advice in an attempt to scare homeowners into selling their homes now. But, several of the form documents realtors use here in Arizona, force both buyer and seller to affirmatively waive any claims you have against them for both financial, legal and tax advice. So, when homeowners learn they have been duped, they have no legal recourse.

The bottom line is, you need to know what your legal rights are. Before making important financial, legal and tax decisions, make sure to speak to someone who is willing to stand behind the counsel they give you so that you can make these important decisions using accurate information.

For more information as to how Robert has helped hundreds of homeowners in Phoenix with understanding tax consequences and more, visit naglelawgroup.com or call (602) 595-3156.

Short Sale - AZ Business Magazine January/February 2012

The Tax Implications From A Short Sale, Foreclosure

The truth of consequences: There can be tax implications from a short sale and foreclosure


The only sure things in life are death and taxes.

And like death, taxes can sometimes sneak up and surprise you. Some homeowners who have faced foreclosure or a short sale might be startled to learn that they may face tax penalties. And many won’t find out that they owe taxes until they open their mail and find a 1099.

“What most owners of residential homes being foreclosed upon or short selling do not realize is how uncertain, complicated and confusing the federal and state income tax rules are that apply to their situation,” says Eliot Kaplan, a partner with Squire Sanders in Phoenix.

So how is it possible that you can lose your home and still owe money?

“Cancellation of debt (COD)  is the term tax professionals use to describe the kind of income that arises for tax purposes when debt is cancelled or forgiven for less than its full face or principal amount,” says Kelly C. Mooney, a shareholder with the law firm of Gallagher & Kennedy in Phoenix. “COD income is specifically included in a taxpayer’s gross income … COD income is always treated as ‘ordinary’ income for federal tax purposes, such that the tax rates applicable to ordinary income — which can be as high as 35 percent for individuals — apply to COD income.”

Thankfully, all upside-down homeowners won’t face tax implications. Under the Debt Forgiveness Act of 2007, any debt forgiven on a loan used to purchase a principal residence is not taxable income. But if you took out a second mortgage, you might be in tax trouble.

For federal income tax purposes, a short sale or a foreclosure — whether via a judicial foreclosure or a trustee’s sale — can trigger income tax consequences, depending on whether the debt at issue is “recourse” or “nonrecourse” for federal tax purposes, says Mooney.

If your mortgage is non-recourse, your lender can’t make you pay the loan. The only thing it can do is foreclose and sell your house for payment on the debt. If the borrower defaults, the lender can seize the collateral, but the lender’s recovery is limited to the collateral.

“If the debt was nonrecourse, meaning the lender had no recourse other than to take the home back, the debt forgiveness is not taxable,” says Dale A. Walters, CPA, Keats, Connnelly and Associates in Phoenix. “However, there will be a reportable gain to the homeowner if the sales price of the home is greater than the mortgage. Many states allow you to walk away from your (no-recourse) mortgage because of anti-deficiency statutes that prohibit lenders from seeking judgments.”

States that have anti-deficiency laws are Arizona, Alaska, California, Connecticut, Florida, Idaho, Minnesota, North Carolina, North Dakota, Texas, Utah, and Washington.

Where homeowners get into tax trouble is if they are facing a foreclosure or short sale and they have taken out a second mortgage or line of credit against their home.

“All second mortgages and lines of credit are recourse loans,” Walters says.

With a recourse loan, you’re personally responsible for repaying the bank or mortgage company. If you don’t repay the loan, or default, the bank can sue you for the remaining amount due on your loan if the proceeds from a foreclosure or short sale don’t cover the amount you owe. While mortgages are typically nonrecourse debt, a foreclosure can trigger the loan to become recourse debt at the request of the lending institution.

“The difference between a ‘recourse’ loan or a ‘nonrecourse’ loan under state law is whether the lender has the right to collect the deficiency,” Kaplan says.

And what about the tax implications?

Kaplan explains using this example: A homeowner purchased a residential home in 2007 for $1 million, used $100,000 cash as a downpayment, took out an interest-only recourse loan of $900,000 that was secured by the residential home, and used the home as his or her personal residence. In 2011, when the residential home had a fair market value of $700,000, the owner voluntarily gave back the home to the lender.

“Using the foreclosure and short sale facts above, if the lender decides as part of the foreclosure or the short sale to forgive the deficiency, the owner will have taxable ordinary income equal to the $200,000 deficiency,” Kaplan says.

“Fortunately, until January 1, 2013, the U.S. and Arizona have provided for relief from having to include the lender forgiveness of the $200,000 deficiency described in the above foreclosure or short sale as taxable income,” Kaplan says.

So how do you know if you’re going to face the tax man after a short sale or foreclosure?
“The best way to know is to ask your tax advisor,” says Lawrence Warfield of Warfield & Company, CPAs in Scottsdale. “The tax from some debt forgiveness can be avoided, but the facts and circumstances of each depend on various scenarios and issues.”

Understanding the terms: Foreclosure and Short Sale

Foreclosure: When a lender acquires ownership of the residential home securing its loan either through the owner of the residential home voluntarily transferring the residential home to lender or through the lender exercising its state law foreclosure rights.

Short sale: When the lender permits an owner of a residential home which secures its loan to sell such residential home for less than what is owed to the lender under the loan. Usually, the lender receives all the proceeds from such sale.


5 questions to ask

Here are some helpful questions that you will need to ask you tax professional:

1. Can I avoid paying taxes on the forgiven debt if I was insolvent at the time of the short sale?
2. Do I have to file bankruptcy to be considered insolvent?
3. If you already went through a short sale and paid taxes can you file an amended return and get a refund?
4. Does a IRS Form 982 have to be filed in order to be eligible for tax relief?
5. Am I protected under the Mortgage Forgiveness Debt Relief Act Of 2007?


Mortgage Forgiveness Debt Relief Act (MFDRA)

Generally, the MFDRA lets you exclude from your taxable income most if not all of any cancelled or forgiven debt that might come about because of a foreclosure. There are limits, however:

1. The cancelled debt has to be on your principal residence. The debt can be from a loan that you took out to buy, build or substantially improve your home. It can also be for refinancing the mortgage on your home. Since it applies only to your principal residence, commercial and vacation properties usually don’t qualify.
2. Only debt that’s forgiven in 2007 through 2012 qualifies.
3. If you file a joint tax return with your spouse, you can exclude up to $2 million of forgiven debt from your income. If you’re married and file separately, you can exclude up to $1 million.
4. You have to report the amount of forgiven debt on a special IRS form, and attach it to your tax return.

Arizona Business Magazine January/February 2012

Investing wisely

Learn To Avoid Investment Mistakes

Avoiding big mistakes can have a significant impact on a long-term investment. This impact may be more significant than the performance of a specific fund, stock, bond, or alternative investment. More often, big mistakes occur when investors begin making decisions based on emotions such as fear and greed, rather than using logic and objectivity when making their decisions about investments. For these reasons, it is important for investors to have a coach on their side, such as a financial professional, to help guide them during challenging times such as we experienced during the 2008 recession. There are many mistakes that can occur, but if the big mistakes can be avoided, it can make a huge difference on an investor’s recovery. Here are three that are critical: failing to plan, waiting for the right moment to start investing, and buying high and selling low.

Many of us have spent countless hours planning for vacations, weddings, graduations, and having children. However, failing to plan for retirement will certainly present major issues for investors when retirement is near. Having a plan in place and a purpose of investing is critical. This is usually broken down in two parts. First, the building of wealth and second the disbursement of wealth. During the wealth-building process, investors will need to consider portfolio growth, time frame of investing, risk tolerance, and tax consequences. During an investor’s disbursement phase, our investment objectives will change and strategies will be tailored toward capital preservation rather than growth. It is not easy and takes a lot of patience, yet having a plan in place to build wealth, and managing it properly during the distribution phase, will improve the odds of having a secure retirement.

When it comes to investing for your retirement, the best time to start is now. Whether you’re a new investor or experienced investor, time is the most important factor you can have on your side. The earlier you start, the easier it is to save more, ride out the shifts of economic changes, and utilize compound interest to your advantage. By starting later in life, investors may fall short of their needs. The later you start the more you will need to save, reduce discretionary spending, and work longer than expected. For these reasons, the earlier you start saving the better the odds of saving enough for retirement.

Emotional investing usually ends on a bad note. Investors who buy and sell on emotions typically buy high and sell low. We have seen this time and time again. The interesting part about this is that most of the time our objective is to get out before we lose or to get in to gain something. In most cases, we end up doing the opposite. We get out before the market shifts because of fear and don’t get in until we are comfortable, when it’s too late. This is why having a plan in place that includes logic and objective decision making is crucial. Usually, a well balanced portfolio with rebalancing will allow investors to meet their goals and minimize major swings in their portfolios.  Avoiding these mistakes does take planning. In many cases, working with a financial professional can help you be more objective and reach your retirement goals.